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THE JOURNAL OF ENERGY

AND DEVELOPMENT

Issa Ali and Charles Harvie,

“Oil-Related Shocks and Macroeconomic


Adjustment under Different
Nominal Exchange Rate Policies:
The Case of the Libyan Economy,”
Volume 40, Number 1

Copyright 2015
OIL-RELATED SHOCKS AND MACROECONOMIC
ADJUSTMENT UNDER DIFFERENT NOMINAL
EXCHANGE RATE POLICIES: THE CASE OF
THE LIBYAN ECONOMY

Issa Ali and Charles Harvie*

Introduction

L ibya is a country heavily dependent on its oil sector since the 1960s and re-
cently has experienced a considerable increase in oil revenue as a result of
increased oil prices particularly after 2000 and oil production rehabilitation since
2011. Like many natural resource-rich developing countries, however, the country
has suffered from widespread corruption, including that related to old oil pro-
duction contracts and a cumbersome bureaucracy, which has resulted in misuse of
oil revenues and poor economic performance. By 2011, the country experienced
a civil war and political turmoil for a period of eight months.1 The civil war, in
conjunction with international sanctions imposed by the United Nations, adversely
affected the domestic economy, in particular the oil sector, and upward pressure

*Issa Ali, Lecturer at the University of Benghazi (Libya), holds a Ph.D. in economics from
University of Wollongong, Australia, and master’s and bachelor’s degrees in economics from the
University of Benghazi. The author’s areas of academic expertise are economic growth and
development, economic modeling, natural resources and macroeconomic development, and in-
ternational monetary economics. The author’s most recent article has been published in Economic
Modelling.
Charles Harvie is an Associate Professor, School of Accounting, Economics & Finance, Faculty
of Business, University of Wollongong (Australia) and is the Director of the Centre for Small
Business and Regional Research and Acting Director of the International Business Research Institute
(IBRI). His research interests include macroeconomics, monetary economics, and transitional
economics.

The Journal of Energy and Development, Vol. 40, Nos. 1 and 2


Copyright Ó 2015 by the International Research Center for Energy and Economic Development
(ICEED). All rights reserved.
23
24 THE JOURNAL OF ENERGY AND DEVELOPMENT

on oil prices occurred and oil-related infrastructure was devastated. According to


the International Monetary Fund’s 2012 Annual Report, the gross domestic pro-
duct (GDP) considerably contracted and crude oil output was almost halted in July
2011.2 Moreover, nonoil economic activity was mainly influenced by the destruc-
tion of infrastructure and production facilities, the departure of foreign workers,
interruptions to the functioning of the banking system, and limited access to
foreign exchange.3 Since the end of the Libyan revolution in late 2011, Libyan oil
production has been rehabilitating, registering about 1.2 million barrels per day
(b/d) by February 2012. As the restoration of oil output continues, with the aim
of reaching the pre-revolutionary level of 1.7 million b/d, significant revenue
will be generated to the domestic economy4 and downward pressure might be
placed on global oil prices. If used effectively, such windfall revenue will play
a critical role in the future prosperity of Libya and challenge the idea of a “resource
curse”;5 alternatively, it could cause adverse effects arising from so-called “Dutch
disease”6 consequences. Therefore, evaluating the impact of windfall revenue aris-
ing from oil production recovery is of considerable contemporary importance not
only to the Libyan economy but also European nations that are the predominant
source of demand for Libyan oil as well as other key regional trading partners.
This paper is concerned with analyzing the dynamic macroeconomic adjust-
ment processes arising from oil output recovery for a small open economy such as
that of Libya, where the role of government is pivotal in the recycling of oil
revenues, operating under different nominal exchange rate regimes. The paper
extends the contribution of I. Ali and C. Harvie by identifying whether the con-
sequences of an oil production recovery (or boom) upon key macroeconomic
variables could be alleviated or improved upon depending on which nominal
exchange rate policy (fixed or flexible) is in place as well as the degree of capital
account liberalization.7 That is, in order to mitigate the adverse effects of an oil
boom upon, say, the nonoil trade balance, moving from a fixed to a flexible
nominal exchange rate policy, combined with perfect capital mobility, might
produce improved macroeconomic outcomes. Under a flexible nominal exchange
rate regime, for example, the exchange rate is capable of adjusting so that capital
flows will have no effect upon foreign exchange reserves. As a result, the nominal
exchange rate is endogenous and growth of the money stock is exogenous.
Therefore, domestic inflation will be influenced only temporarily by the difference
between nonoil output supply and demand.
The remainder of this paper proceeds as follows. The next section outlines the
theoretical framework adopted and model equations for the case where a fixed
exchange rate is adopted and the case where a flexible exchange rate is adopted.
The model also allows for varying degrees of capital mobility. In the subsequent
simulation, outcomes from the model for the case of an oil production shock under
a fixed and flexible exchange rate regime are compared and contrasted. Last, we
offer our concluding remarks.
LIBYA: OIL-RELATED SHOCKS & EXCHANGE RATES 25

Theoretical Framework: The Model

The dynamic macroeconomic model utilized in this paper has its foundation in
the contributions of R. Dornbusch, W. Buiter and M. Miller, R. Eastwood and A.
Venables, W. Buiter and D. Purvis, J. Neary and S. Van Wijnbergen, C. Harvie
and L. Gower, C. Harvie and A. Thaha, and, more recently and importantly, G.
Cox and C. Harvie (hereafter C-H) for the case of a flexible exchange rate in the
context of advanced resource-abundant economies, and I. Ali and C. Harvie
(hereafter A-H) for the case of a fixed exchange rate in the context of a developing
resource-abundant country.8 In particular, the C-H model and the A-H model are
dynamic general equilibrium models focusing on the long-run nature of the ad-
justment process. An important feature of the C-H model is the role of financial
markets in transmitting the effects of oil-related shocks to the rest of the economy.
The A-H model assumes, however, that such a transmission mechanism is not
applicable for an oil-producing developing economy such as Libya, where fi-
nancial markets are unsophisticated, tightly controlled, and the economy is op-
erating with a fixed exchange rate regime and controls over international capital
flows.
Like the A-H model, the general means by which oil-related shocks transmit
their impact to the rest of the economy is via a number of common oil-related
effects. First, increased oil-sector production (revenue) will generate increased
revenue for the government (revenue effect). Second, increased government
consumption and development expenditure from oil revenue will generate a
spending effect. Third, increased oil exports will lead to an accumulation of for-
eign asset stocks through improved trade and current account balances (trade or
current account effect). Fourth, increased future oil income also can contribute to
an increase in permanent income (wealth effect) for both the government and the
private sector that can further influence spending. In the context of Libya the bulk
of this wealth effect primarily will accrue to the government. Fifth, the extra
spending generated by the spending and wealth effects increase the demand for
nonoil output relative to its available supply. This can push up domestic prices
and, with a fixed nominal exchange rate, result in an effective appreciation of the
real exchange rate (exchange rate effect) and loss of competitiveness for the nonoil
sector. Furthermore, like the A-H model, this paper will capture other long-run
effects, including human capital stock accumulation (a labor productivity effect)
and imported capital stock accumulation via capital imports (a technology effect),
emphasizing the supply side in a dynamic modeling context. These effects will
expand the long-run productive capacity and efficiency of the nonoil sector.
The Ali and Harvie study evaluates by means of numerical simulation the
effects of additional oil revenue, arising from oil-related shocks, upon key mac-
roeconomic variables, including the real exchange rate, nonoil trade balance,
foreign asset stocks, human capital stock, physical capital stock, imported capital
26 THE JOURNAL OF ENERGY AND DEVELOPMENT

stock, and nonoil output supply. The important results observed are that the country’s
oil sector recovery potentially will result in an increase in private capital stock and
private-sector wealth, real income, domestic physical capital stock, human capital
stock, imported capital stock, and nonoil supply (and demand). Dutch disease effects
are likely to be confined to the nonoil trade balance during the adjustment process
toward a long-run steady state. That is, a recovery of the oil sector also has the
potential to deteriorate the nonoil trade balance through a loss of competitiveness
from a real exchange rate appreciation. Nevertheless, despite the loss of competi-
tiveness of the nonoil tradable sector, nonoil output supply increases throughout the
early periods of adjustment. This is attributable to the fact that the Dutch disease
effect upon nonoil output can be mitigated by government development spending on
physical, human, and imported capital stocks.9 In the context of the Libyan economy,
this confirms the essential role that the government, which owns the oil sector, must
play in enhancing the positive consequences and/or minimizing the adverse effects of
the oil-sector recovery upon the nonoil sector.10 The government could improve
productivity and increase the availability and type of capital available for the nonoil
sector by increasing or changing the composition of government investment ex-
penditure on infrastructure, human capital formation, and technology acquisition in
this sector. This eventually will improve the nonoil sector’s competitiveness.
The model utilized in this paper is basically the same as that extensively dis-
cussed by Ali and Harvie with a minor, but important, change. The equations of
the model are amended to incorporate movement from a fixed to flexible nominal
exchange rate regime combined with perfect capital mobility. A brief discussion
of the model is now presented.11 Equilibrium in the model depends upon equi-
librium in the product market, assets market, and foreign trade sector. The product
market is discussed first.

Product Market: Equations (1) to (18) describe the product market. Equation
(1) describes the total demand for nonoil output (Nod). It is a log linear approxi-
mation of total spending in the form of private consumption spending (cp), private
investment spending (ip), government spending (g), and the nonoil trade balance
consisting of nonoil exports (xn) and nonoil imports (mn). The parameters (bi)
represent the elasticities of spending in each category. The parameters are based
on the contribution of a dollar spent on private consumption and investment, total
government spending, nonoil exports, and nonoil imports to the demand for nonoil
output. In line with the C-H model, the parameters are set to 1 indicating that a dollar
spent in any of these components contributes equally to nonoil product demand.

Nod = b1 c p + b2 ip + b3 g + b4 ðxn  mn Þ ð1Þ

Private consumption expenditure is given by equation (2). It depends positively


upon nonoil output supply and private sector wealth. The production of nonoil
LIBYA: OIL-RELATED SHOCKS & EXCHANGE RATES 27

output represents income generated by the public and private sectors, although
most nonoil output is produced by the public sector in Libya.12 Equation (3) de-
scribes private-sector gross investment, which equals the change in the stock of
private capital and is based on the partial adjustment hypothesis. 13 This partial
adjustment arises from costs of adjusting the actual physical capital stock (kp) to
the desired capital stock (k p*). The increase in capital from the end of the previous
period to the end of the current period is some fraction g of the divergence be-
tween the desired and actual stock of capital. The adjustment coefficient g was
selected to be 0.50, indicating moderate adjustment of the dependent variable. The
desired capital stock is assumed to depend upon nonoil output—see equation (4)—
where the parameter d is set to be 0.8.

cp = b6 Nos + b7 w p ð2Þ

ip = k_ = gðk p*  k p Þ
p
ð3Þ
k p* = dNos ð4Þ

Total government spending (g) is identified by equation (5). It depends posi-


tively on two components of expenditure: government consumption spending (cg),
which is assumed to be dependent upon oil revenue as shown in equation (6), and
government development expenditure. Government development spending is di-
vided into three parts: government development spending on physical capital (for
example, infrastructure) (ig); government development spending on human capi-
tal (for example, education and health care) (ih); and that devoted to imported
capital (for example, imported foreign technology) (icap). Equation (5) parameters
are based on the relative weight of each of these spending components in total
government spending. Equations (7), (8), and (9) describe government investment
spending on the physical, human, and imported capital stocks, respectively, which
arises from a gradual adjustment of the actual public capital stock to their policy-
determined levels. The policy-determined levels are determined by oil revenue,
as given by equations (10), (11), and (12). For adjustment equations (7), (8), and
(9), the adjustment coefficients were selected to be 0.50, indicating moderate
adjustment of the dependent variables. The parameters for equations (6), (10),
(11), and (12) were chosen as weighted averages, indicating how the govern-
ment distributes oil revenue among desired physical capital stock, desired hu-
man capital stock, desired imported capital stock, and consumption expenditure
according to its policy priorities.14 The summation of these parameters is one, as
all oil revenue goes to the government and this is totally disbursed in the previous
four ways.

g = b8 cg + b9 is + b10 ih + b11 icap ð5Þ


28 THE JOURNAL OF ENERGY AND DEVELOPMENT

cg = ð1  u1  u2  u3 Þðoa + po + e  pÞ ð6Þ

is = k_ = uðk s*  k s Þ
s
ð7Þ

ih = k_ = sðk h*  k h Þ
h
ð8Þ

icap = k_
cap
= lðk cap*  k cap Þ ð9Þ

k s* = u1 ðoa + po + e  pÞ ð10Þ

k h* = u2 ðoa + po + e  pÞ ð11Þ

k cap* = u3 ðoa + po + e  pÞ ð12Þ

Equation (13) identifies the budgetary stance, which is government expenditure


(g) less tax revenues (tx). In Libya, the government issues bonds to the central bank
only; therefore, equation (13) shows that any excess of government expenditure
over tax revenue must be financed by borrowing domestically from the Central
Bank of Libya (CBL). Tax revenue is generated from two sources, oil production
and nonoil production—equation (14). The parameter (b13) in equation (14) is set
to 0.70 as the bulk of government revenue comes mainly from oil, with oil revenue
contributing 70 percent on average of total government revenue during the period
1970–2007.

bd = g  t x = b12 ðm_  pÞ
_ ð13Þ
t x = b13 ðoa + po + e  pÞ + ð1  b13 ÞNos ð14Þ

The nonoil trade balance is disaggregated into nonoil exports less nonoil im-
ports as shown in equation (15) and identity equation (30). Equation (15) specifies
that nonoil exports (xn) depend positively upon the real exchange rate (e + p* — p)
and world real income (y*), which is assumed to be exogenous. Nonoil imports
also are disaggregated into nonoil consumption imports (mcon) and nonoil capital
imports (icap). Equation (16) identifies nonoil consumption imports, which depends
negatively upon the real exchange rate and positively on domestic real income (y).
Equation (9) identifies nonoil capital imports, which are assumed to be endoge-
nously determined, arising from a gradual adjustment of actual imported capital
spending to its policy-determined level. The parameters in behavioral equations
(15) and (16) were empirically estimated using the autoregressive distributed lag
(ARDL) approach. Table 1 provides the parameters, table 2 tests for the existence
of a long-run relationship among the variables, and table 3 provides the ARDL
results.
LIBYA: OIL-RELATED SHOCKS & EXCHANGE RATES 29

Table 1
a
PARAMETERS VALUES

b1*** 1.00 u1** 0.30 e7*** 1.00


b2*** 1.00 u2** 0.20 t*** 0.20
b3*** 1.00 u3** 0.20 m1*** 0.60
b4*** 0.75 b12** 1.00 m2*** 0.10
b6* 0.60 b13* 0.70 c1* 0.65
b7* 0.30 b14* 0.45 c2* 0.40
g*** 0.50 b15* 0.50 f1* 0.10
d* 0.80 b16* 0.75 f2* 0.50
b8** 0.40 b17* 0.25 f3* 0.40
b9** 0.30 n** 0.70 f4* 0.30
b10** 0.15 e1* 0.40 f5* 0.20
b11** 0.15 e2* 0.36 a1* 0.15
u*** 0.50 e3* 0.09 a2* 0.50
s*** 0.50 e5*** 1.00 a3* 0.35
l*** 0.50 e6*** 1.00 j*** 0.30
rs*** 0.05

a
*= estimated coefficients obtained using autoregressive distributed lag (ARDL) approach as
contained in table 1, see I. Ali and C. Harvie, “Oil and Economic Development: Libya in the Post-Gaddafi
Era,” Economic Modelling, vol. 32, issue C (May 2013), pp. 273–85; ** = calculated by the authors based
on available data; and *** G. M. Cox and C. Harvie, “Resource Price Turbulence and Macroeconomic
Adjustment for a Resource Exporter: A Conceptual Framework for Policy Analysis,” Energy Economics,
vol. 32, no. 2 (2010), p. 469–89 and C. Harvie and A. Thaha, “Oil Production and Macroeconomic
Adjustment in the Indonesian Economy,” Energy Economics, vol. 16, no. 4 (1994), pp. 253–70.

xn = b14 ðe + p*  pÞ + b15 y* ð15Þ


mcon = b16 y  b17 ðe + p*  pÞ ð16Þ

Real and permanent income (yp) definitions, first used by W. Buiter and D.
Purvis, are given by equations (17) and (18).15 Real income, as identified in
equation (17), depends upon nonoil output (Nos), oil production (oa) that is as-
sumed to be exogenous, the world price of oil (po), that is also exogenous, the real
exchange rate as emphasized here and the exogenously determined price of nonoil
imported goods (p*). Equation (18) represents permanent income, which depends
on exogenous permanent nonoil output (Nosp), exogenous permanent oil output (op ),
the world price of oil, the real exchange rate, and price of nonoil imported goods
(see C. Harvie).16 The parameters in identities (17) and (18) are based upon the
calculated share of current and permanent oil output in total current and permanent
output, respectively. It is assumed that v, the share of current and permanent nonoil
production in total current and permanent income, is the same in real and permanent
30 THE JOURNAL OF ENERGY AND DEVELOPMENT

Table 2
TESTING FOR THE EXISTENCE OF A LONG-RUN RELATIONSHIP AMONG THE
a
VARIABLES

95% 95% 90% 95%


Lower Upper Lower Upper Computed
Equation Bound Bound Bound Bound F-Statistic

Fðc p =Nos ; wP ; D83 ; D2000 Þ 7.1331 8.1223 5.9643 6.8483 8.5036


Fðxn =ðe + p*  pÞ; y*; D78 ; D2000 Þ 7.2027 8.0224 5.9599 6.8090 9.5687
Fðmcon =y; ðe + p*  pÞ; D87 ; D2003 Þ 6.8999 7.9831 5.7676 6.7289 6.9717
  p=No ; r; p;
_ D81 Þ
s
Fðm 4.9827 5.9803 4.1361 5.0154 6.1426
_
F w=ðNo d
 Nos ; pÞ _  2.8906 4.1355 2.2636 3.3349 6.7978
F Nos =k p ; k g ; k h ; em; k cap ; D89 3.6605 5.0006 3.0991 4.2756 6.2444
F f_=T ; r*f ; ðoX + poÞ; ðe  pÞ 4.0285 5.3829 3.3851 4.6270 5.9057

a
Critical values are obtained directly from the empirical results generated by Microfit 5.

income and constant through time (see W. Buiter and D. Purvis).17 The share of oil
output in domestic real income (1– v) is set deliberately to be larger than its share in
domestic consumption (m2), resulting in the Libyan economy being a net oil ex-
porter in the model.

y = vNos + ð1  vÞoa + ð1  v  m2 Þpo + ðm1  vÞðe  wÞ


 ð1  m1  m2 Þp* ð17Þ

y p = vNosp + ð1  vÞop + ð1  v  m2 Þpo + ðm1  vÞðe  wÞ


 ð1  m1  m2 Þp* ð18Þ

Assets Market: The asset market is encapsulated by equations (19) through


(21). The behavioral equation (19) describes the demand for real money balances
(the nominal money stock m deflated by the consumer price level p). It depends
positively upon real nonoil income (Nos), representing a transactions demand, and
negatively upon the interest rate representing an asset demand. The interest rate is
subject to regulation by policy makers in Libya and it is no longer a good proxy
for the cost of holding money. Therefore, the rate of inflation is utilized, besides
the interest rate, as a proxy variable for the opportunity cost of holding money in
the A-H model. The nominal money supply is assumed to be endogenous as the
nominal exchange rate is fixed. The estimated parameters of equation (19) are
shown in table 3.

m  p = e1 Nos  e2 p  e3 r ð19Þ
Table 3
ESTIMATED LONG-RUN COEFFICIENTS USING THE AUTOREGRESSIVE DISTRIBUTED LAG (ARDL) TECHNIQUE FOR
EQUATIONS (2), (15), (16), (19), (23), (24), AND (25)

Equation (2): The long-run coefficient estimates based on ARDL (3,0,0) and selected lag based on Akaike information criterion (AIC)
Pn p Pn s
Pn p p s p
Dcp = a0 + j = 1 bj Dctj + j = 0 cj DNotj + j = 0 d j Dwtj + d1 ct1 + d2 Not1 + d3 wt1 + d4 D83 + d5 D2000 + et
s p
Variables No w Constant Trend D1983 D2000
Coefficients 0.6636 0.4438 –0.6310 –0.0533 –0.1423 0.0872
t-statistics 2.9561 2.1632 –0.8602 –4.2839 –1.6100 0.9116
2
R = 0.74 D–W= 2.10

Equation (15): The long-run coefficient estimates based on ARDL (1,0,0) and selected lag based on AIC
Pn n
Pn Pn n
Dxn = a0 + j = 1 bj Dxtj + j = 0 cj Dðe + p*  pÞtj + j = 0 d j y* * + d4 D78 + d5 D2000 + et
tj + d1 xt1 + d2 ðe + p*  pÞtj + d3 yt1
Variables (e + p*– p) y* Constant Trend D1978 D2000
Coefficients 0.4735 5.0362 –113.30 –0.2154 –0.1012 2.0708
t-statistics 1.4607 2.3759 –2.3044 –2.0094 –0.1869 2.0416
2
R = 0.60 D–W= 2.03

Equation (16): The long-run coefficient estimates based on ARDL (1,0,0) and selected lag based on AIC
Pn com
Pn Pn com
Dmcom = a0 + j = 1 bj Dmtj + j = 0 cj Dytj + j = 0 d j Dðe + p*  pÞtj + d1 mt1 + d2 yt1 + d3 ðe + p*  pÞtj + d4 D87 + d5 D2003 + et

Variables (e + p*– p) y Constant Trend D1987 D2003


Coefficients – 0.2565 0.7438 2.4202 –0.0355 0.6507 –0.6605
t-statistics –2.2490 3.5753 1.4721 –2.0950 2.1544 –1.9677
2
R = 0.67 D–W= 2.31

(continued)
LIBYA: OIL-RELATED SHOCKS & EXCHANGE RATES
31
Table 3 (continued)
32

ESTIMATED LONG-RUN COEFFICIENTS USING THE AUTOREGRESSIVE DISTRIBUTED LAG (ARDL) TECHNIQUE FOR
EQUATIONS (2), (15), (16), (19), (23), (24), AND (25)

Equation (19): The long-run coefficient estimates based on ARDL (1,0,1,0) and selected lag based on AIC
s
Pn Pn Pn Pn
Dðm  pÞ = a0 + j = 1 bj Dðm  pÞtj + j = 0 cj DNotj + j = 0 d j Drtj + j = 0 ej Dp
_ tj + d1 ðm  pÞt1 + d2 Nost1 + d3 rtj + d4 p_ t1
+ d5 D81 + et
s
Variables No p r Constant D1987 D2003
Coefficients 0.4102 –0.3624 –0.0987 1.3204 –0.0738 –0.1166
t-statistics 10.1153 –3.1979 –1.5171 1.8935 –1.6850 –1.6537
2
R = 0.76 D–W= 2.14

Equation (23): The long-run coefficient estimates based on ARDL (1,0,1) and selected lag based on AIC
d s
Pn Pn Pn
Dw_ = a0 + _ tj +
j = 1 bj Dw j = 0 cj DðNo  No Þtj + j = 0 d j Dp
_ tj + d1 w_ t1 + d2 ðNod  Nos Þt1 + d3 p_ tj + et
d s
Variables (No – No ) p_
Coefficients 0.6778 0.4109
t-statistics 1.6985 2.2924
2
R = 0.73 D–W= 2.13

Equation (24): The long-run coefficient estimates based on ARDL (2,0,1,2,0,0) and selected lag based on AIC
Pn s
Pn p Pn g Pn h Pn Pn cap s p
DNos = a0 + j = 1 bj DNotj + j = 0 cj Dk tj + j = 0 d j Dk tj + j = 0 ej Dk tj + j = 0 f j Dltj + j = 0 g j Dk tj + d1 Not1 + d2 k t1

+ d3 k gt1 + d4 k ht1 + d5 lt1 + d6 k cap


t1 + d7 D89 + et
p g h cap
Variables k k k k em Constant D1996
Coefficients 0.0866 0.5061 0.5225 0.3105 0.2014 –2.4822 0.0416
t-statistics 0.9019 4.2342 2.4162 2.0154 2.1358 –2.1223 0.3905
THE JOURNAL OF ENERGY AND DEVELOPMENT

2
R = 0.87 D–W= 1.93

(continued)
Table 3 (continued)
ESTIMATED LONG-RUN COEFFICIENTS USING THE AUTOREGRESSIVE DISTRIBUTED LAG (ARDL) TECHNIQUE FOR
EQUATIONS (2), (15), (16), (19), (23), (24), AND (25)

Equation (25): The long-run coefficient estimates based on ARDL (2,0,2,0,0) and selected lag based on AIC
Pn Pn _ Pn *
Pn x
Pn _
Df_ = a0 + j = 1 cj DT tj + j = 0 bj Df tj + j = 0 cj Dr f tj + j = 0 d j Dðo + poÞtj + j = 0 ej Dðe  wÞtj + d1 f t1

+ d2 T t1 + d3 r*f t1 + d4 ðox + poÞt1 + d5 ðe  wÞt1 + et


x
Variables T r*f (o + po) (e – p) Constant Trend
Coefficients 0.1506 0.5175 0.3250 –0.3787 –0.9352 0.0058
t-statistics 1.1327 4.1594 2.0135 –1.2976 –1.3189 1.8155
2
R = 0.86 D–W= 2.16
LIBYA: OIL-RELATED SHOCKS & EXCHANGE RATES
33
34 THE JOURNAL OF ENERGY AND DEVELOPMENT

Domestic private-sector real wealth (w p) is given by equation (20) and consists


of three components. The first component is private capital stock, which is owned
entirely by the private sector. The second major component is real money bal-
ances, which consists of cash, deposits, and savings of the private sector. The final
component is permanent nonoil income equivalent to that of permanent nonoil
output.18 The parameters in equation (20) are set to 1, indicating the equal im-
portance of each of the components to total private-sector wealth.

w p = e5 k p + e6 ðm  pÞ + e7 y p ð20Þ

Equation (21) shows the money growth equation. It indicates the assumption of
a fixed exchange rate combined with imperfect capital mobility. Since a fixed
exchange rate is assumed for the case of Libya, the money supply and its growth is
endogenously determined. It depends upon exogenously determined changes in
domestic credit expansion (dċe) and the accumulation of foreign exchange re-
̇ (see C. Harvie, and C.
serves through balance of payments surpluses/deficits (fes)
19
Harvie and A. Thaha), as shown in equation (21*).
_ = d ce
m _ + f es
_ ð21*Þ

dċe is exogenously determined by government and is assumed for simplicity to be


equal to zero. Changes in foreign exchange reserves arise from developments in
the current account (f_) and from capital flows due to differences in the domestic
and foreign nominal interest rate (r – r*), as shown in equation (21**), where t
denotes the sensitivity of capital flows to interest rate differentials, representing
the degree of capital mobility. The value of coefficient t can range from zero to
infinity. The greater is t the greater is international capital mobility, while the
smaller is t the smaller is international capital mobility.20 The parameter t is
chosen to be 0.2 in this base model, which is indicative of the substantial control
over capital mobility exercised by the government.

_ = t ðr  r*Þ + f_
f es ð21**Þ

By substituting equation (21**) into equation (21*), equation (21) is obtained.


 
_ + tðr  r*Þ + f_
m_ = d ce ð21Þ

Aggregate Supply and Prices: Equations (22) through (24) define the price
level and aggregate nonoil output supply. Price and inflationary expectations
developments are given by equations (22), (23), and (24). Equation (22) de-
fines the consumer price level, which is a weighted average of nominal wages,
the domestic cost of oil, and the domestic cost of the world nonoil imported
good. The weights used in the consumer price index in equation (22) are
LIBYA: OIL-RELATED SHOCKS & EXCHANGE RATES 35

approximated, based on Libyan data. Adjustment of nominal wages is generated


by an expectations augmented Phillips curve, as given by equation (23). Two
possible adjustment sources are considered, these being excess demand for nonoil
goods relative to its available supply (Nod – Nos) and core inflation (p). Core in-
flation depends upon developments in the monetary growth rate—equation (21).
The estimated parameters of equation (23) are contained in table 3.

p = m1 w + m2 ðe + poÞ + ð1  m1  m2 Þðe + p*Þ ð22Þ


 
w_ = y1 Nod  Nos + y2 m_ ð23Þ

Aggregate nonoil output supply is endogenously determined, as given by equa-


tion (24). It depends positively on the public capital stock,21 human capital stock,
private capital stock, imported capital stock, and employment. Government in-
vestment is divided into three parts: capital that affects nonoil output through
physical capital stock accumulation, capital that affects nonoil output through
human capital formation, and capital imports. The estimated parameters of equation
(24) are shown in table 3.

Nos = f1 k p + f2 k g + f3 k h + f4 k cap + f5 em ð24Þ

Overseas Sector: The external sector consists of the current account and the
oil trade balance. Developments in the current account are given by equation (25a)
(see, for example, C. Harvie and C. Harvie and L. Gower).22

f_ + e  p = a1 T + a2 ðr*f + e  pÞ + a3 ðox + po + e  pÞ ð25aÞ


x
where (o ) represents net exports of oil. Re-arranging equation (25a) and
expressing this in terms of changes in foreign exchange reserves, equation (25) is
obtained. This shows that changes in foreign exchange reserves, as reflected in the
current account balance (f_), depends positively upon the nonoil trade balance, as
given by equation (29), foreign interest income (r* f), net oil exports and on the
real exchange rate (e –p). In the long-run steady state the current account balance
must be zero, otherwise further wealth effects will arise requiring further mac-
roeconomic adjustment. Equation (25) is as in the C-H model. The estimated
parameters of this equation are contained in table 3.

f_ = a1 ðxn  mn Þ + a2 r*f + a3 ðox + poÞ  ð1  a2  a3 Þðe  pÞ ð25Þ

Equation (26) indicates that net oil exports are exogenously determined, being
dependent upon government policy toward the domestic usage or export of oil
production. The parameter in equation (26) has been selected as 0.70, indicating
a more export-oriented policy.
36 THE JOURNAL OF ENERGY AND DEVELOPMENT

ox = joa ð26Þ

Definitions: Finally, equations (27) through (30) define four variables, which
are used extensively throughout this study. Equation (27) defines the real exchange
rate as used in this study, equation (28) defines real money balances, equation (29)
defines the nonoil trade balance, and equation (30) defines nonoil imports.

c=e  w ð27Þ

l=m  w ð28Þ
T = xn  mn ð29Þ
mn = mcon + icap ð30Þ

Alternative Exchange Rate Policy: The above discussion has focused on an


economy operating with a fixed exchange rate regime. With a flexible nominal
exchange rate, some amendments are required. Moving from a fixed to flexible
nominal exchange rate combined with perfect capital mobility requires re-
placement of equation (21) by equation (21a) in the model.
e_ = r  r* ð21aÞ

With a flexible nominal exchange rate regime the exchange rate is capable of
adjusting so that capital flows will have no effect upon foreign exchange reserves.
As a result, the nominal exchange rate is endogenous and growth of the money
 Therefore, domestic inflation will only be temporarily
stock is exogenous (m = m).
influenced by the difference between nonoil demand and output supply. Equation
(21a) is the uncovered interest parity condition. It encapsulates the assumption of
perfect capital mobility and perfect foresight in the foreign exchange market. It
assumes that in the foreign exchange market agents have forward-looking ex-
pectations and anticipate that, when the economy is out of steady state, it will
converge ultimately to a new steady state.

Simulation Results Arising from Oil Production Rehabilitation under a Fixed


and Flexible Exchange Rate Regime

This section analyses the consequences from the adoption of alternative


exchange rate regimes upon the Libyan macro-economy for the case of oil
production rehabilitation. Two different nominal exchange rate regime sce-
narios are conducted. Scenario A assumes a fixed nominal exchange rate
LIBYA: OIL-RELATED SHOCKS & EXCHANGE RATES 37

combined with imperfect capital mobility, while scenario B presumes a flexible


nominal exchange rate regime combined with perfect capital mobility. A
simulation analysis is conducted utilizing a program called “Dynare,” which is
designed for solving and simulating deterministic and stochastic dynamic
general equilibrium models (see S. Adjemian et al.).23
The parameter values utilized to conduct the numerical simulation scenarios
are summarized in table 1. It contains 19 estimated parameters for behavioral
equations (2), (15), (16), (19), (23), (24), and (25), using the ARDL cointegration
approach,24 where they are significantly different from zero (see table 3). The
remaining parameters summarized in table 1 were chosen from prior studies
and/or calculated from available data. However, before the behavioral equations
are estimated, the major structural break(s) in the intercept and trend using the LM
unit root test of J. Lee and M. Strazicich are identified and incorporated in the
estimated equations.25 Furthermore, testing for the existence of a long-run re-
lationship among the variables is conducted, where the results presented in table 2
_ Nos,
indicate conclusive outcomes for the dependent variables cp, xn, mcap, m – p, w,
and f_ as computed F-statistics are greater than the upper bound critical values. The
exception to this result is the computed F-statistic for mcon, where the result is
inconclusive at the 95-percent level as the computed F-statistic is greater than the
lower bound but less than the upper bound; however, it is conclusive at the 90-
percent level. These results imply that the variables of interest are bound together
in a long-run relationship.
Generally, as indicated in table 4 and figure 1, moving from a fixed to flexible
nominal exchange rate regime brings about different outcomes during the dy-
namic adjustment process and, in particular, for the nonoil trade balance. The
key variables that contribute to this difference are the inflation rate and nominal
exchange rate. The results suggest that the adoption of an alternative exchange
rate policy not only leads to a reduction of Dutch disease consequences in the
early periods of adjustment, but it also can enhance the supply of and demand for
nonoil output.

Table 4
STEADY STATE PROPERTIES OF THE MODEL FOR ALTERNATIVE NOMINAL
EXCHANGE POLICY REGIMES (SCENARIOS A AND B)
(in percentage deviation from the base line)

Case for Oil Production Increase: Scenario A


p s g h cap p
f T c w y No k k k k
23 –11.5 0.0 25 23 16 15 10 10 17
Case for Oil Production Increase: Scenario B
p s g h cap p
f T c w y No k k k k
23 –10.5 0.0 27.5 25 19 16 11 11 20
38 THE JOURNAL OF ENERGY AND DEVELOPMENT

Simulation outcomes for foreign asset stocks, as seen in figure 1, show that
they initially increase in both scenarios, but this is more rapid in scenario B,
signifying higher current account surpluses during the early stage of adjustment.
Foreign asset stocks decline slightly for scenario B thereafter, before returning to
long-run steady state where it has accumulated by 23 percent. This arises from an
immediate increase in oil exports and surplus in the oil trade balance and an in-
crease in foreign interest income, which offset the deficit in the nonoil trade
balance in both scenarios. The result indicates that a flexible nominal exchange
rate combined with perfect capital mobility produces a significant accumulation of
foreign asset stocks during the early period of adjustment. This is mainly due to the
fact that the deficit in the nonoil trade balance is less in scenario B compared to
that of A during the early periods of adjustment (see figure 1).
The price level initially increases by almost 4 percent during the adjustment
process for the fixed nominal exchange rate regime scenario (scenario A), and
remains above base line for a period of time before it achieves its long-run steady
state equilibrium. The adjustment of the price level in the early periods is es-
sentially influenced by oil export revenue that contributes to an accumulation of
foreign asset stocks (current account effect), which in turn affects money growth
due to balance of payments surpluses and also generates increased spending.
The result would be different with a flexible exchange rate as an increase in oil
revenue would not influence the monetary growth rate, but, rather, appreciate the
nominal and real exchange rate. This is true as the flexible exchange rate regime
allows the economy to retain control over its money supply compared to that of
a fixed exchange rate. Thus, the adjustment of the domestic price level reflects the
adjustment of the nominal exchange rate. The price level increases by only 2
percent in scenario B in the early periods of the adjustment process and returns
quickly to its initial value thereafter.
Developments in the domestic price level affect the evolution of the real ex-
change rate during the adjustment process. The real exchange rate initially appre-
ciates throughout the adjustment path with the adoption of a fixed nominal exchange
rate regime (scenario A) by 6 percent, overshooting its long-run steady state. Also,
the appreciation of the real exchange rate for scenario A is larger and is more
prolonged before it depreciates toward long-run steady state. The main reason for
this is that the higher domestic price level for scenario A, induced by money growth
and the difference between nonoil demand and nonoil supply, remains above the
base line for a long period of time before reaching its long-run steady state.
With a flexible nominal exchange rate regime the real exchange rate appre-
ciates by less (3 percent), induced by a smaller increase in the domestic price level
for scenario B. The price level is unaffected by money growth, but it is, rather,
influenced by developments in the nominal exchange rate. Thereafter, the real
exchange rate depreciates faster than that of scenario A toward its initial value as
the price level returns quickly to its initial value.
LIBYA: OIL-RELATED SHOCKS & EXCHANGE RATES 39

Development of the nonoil trade balance is influenced by the adjustment path


of the real exchange rate in both scenarios. The nonoil trade balance deteriorates
throughout the dynamic adjustment process in both scenarios, with a noticeably
larger deterioration in scenario A where it initially deteriorates by almost 14 percent.
The deterioration of the nonoil trade balance in the case of a fixed exchange rate,
scenario A, is due to a combination of (1) increasing nonoil imports arising from an
increase in real income and (2) a decline in nonoil exports throughout the dynamic
adjustment process influenced by the initial sizeable appreciation of the real ex-
change rate. On the other hand, the deterioration of the nonoil trade balance in the
case of a flexible exchange rate, scenario B, is due mainly to an increase in nonoil
imports stimulated by a larger increase in real income. Nonoil exports experience
a minor decline in the early stage of adjustment in scenario B, influenced by
a smaller appreciation of the real exchange rate and a prompt return to its base value
thereafter. The smaller deterioration of the nonoil trade balance in scenario B means
that the competitiveness of nonoil exports is superior with the flexible nominal
exchange rate regime combined with perfect capital mobility.
Nonoil production increases continuously in both scenarios throughout the
adjustment path toward long-run steady state, but it increases more in the case of
the flexible exchange rate regime (scenario B). The main contributory factor for
this difference is an increase in nonoil production in scenario B, which is stimu-
lated by an accumulation of physical capital stock, human capital stock, imported
capital stock, and private capital stock on the supply side, but also by an improved
situation for nonoil exports arising from a smaller appreciation of the real ex-
change rate as compared with that of scenario A. As can be seen from table 4 and
figure 1, public physical capital stock, human capital stock, imported capital stock,
and private capital stock accumulate in the early periods of adjustment toward
their long-run steady state. All capital stocks accumulate more with a flexible
exchange rate regime, mainly in the early periods of adjustment. This is due to two
reasons: (1) as mentioned earlier, the flexible exchange rate regime offers sig-
nificant accumulation of foreign asset stocks, particularly during the early periods
of adjustment process, which could be used for more accumulation of imported
capital stock, and (2) government real oil revenue increases more under a flexible
nominal exchange rate system as the economy is insulated from inflation arising
from growth of the money supply. Therefore, the larger government real oil
revenue, the larger is the accumulation of public physical capital stock and human
capital stock. This implies that the major benefits from increased oil production
are upon all capital stocks and, in turn, upon nonoil production arising from
scenario B (flexible exchange rate regime combined with perfect capital mobility).
The simulation results also indicate that private real wealth increases contin-
uously in both scenarios throughout the adjustment path toward long-run steady
state. It increases more in scenario B, where it increases by 27.5 percent, compared
with 25 percent in scenario A. Developments in real private wealth are induced
40 THE JOURNAL OF ENERGY AND DEVELOPMENT

mainly by a significant accumulation of private capital stock, real money balances,


and permanent income.
Overall, the alternative policy of a flexible nominal exchange rate regime,
combined with perfect capital mobility, offers significant accumulation of foreign
asset stocks in the early stage of adjustment,26 and the competitiveness of nonoil
exports improves with a flexible nominal exchange rate regime as the real ex-
change rate only slightly appreciates during the adjustment path and returns
swiftly to base line. Thus, the deterioration of the nonoil trade balance was due to
the larger increase in nonoil imports stimulated by a larger increase in real income.
Therefore, it can be argued that Dutch disease consequences can be further min-
imized by moving from a fixed to flexible exchange rate regime in conjunction
with greater capital account liberalization. A flexible nominal exchange rate policy
provides greater benefits for nonoil production, induced on the supply side by a
larger accumulation of public physical capital stock, human capital stock, im-
ported capital stock, and private capital stock. It is also stimulated on the demand
side by the improved competitiveness of nonoil exports. Moreover, private-sector
benefits from the flexible exchange rate regime are induced mainly by an increase
in private capital stock.

Concluding Remarks

This paper has utilized a dynamic general equilibrium macroeconomic model


for the Libyan economy, aimed at evaluating the effects of additional oil revenue
upon key macroeconomic variables under different exchange rate regimes. The
simulation scenario of a fixed exchange rate with imperfect capital mobility in-
dicated that a permanent oil production increase by 50 percent would potentially
result in an increase in private capital stock, private-sector wealth, real income,
public capital stock, human capital stock, imported capital stock, nonoil output
supply, and demand. However, the oil sector boom also has the potential to de-
teriorate the nonoil trade balance through a loss of competitiveness from a real
exchange rate appreciation and increasing nonoil imports arising from an increase
in real income. On the other hand, for a flexible exchange rate regime with perfect
capital mobility, outcomes also suggest that the competitiveness of nonoil exports
only slightly deteriorates as the real exchange rate only slightly appreciates during
the early part of the adjustment process. Hence, the deterioration of the nonoil
trade balance was less and was due primarily to the larger increase in nonoil
imports stimulated by an increase in real income. The Dutch disease effects,
therefore, are potentially reduced by moving from a fixed to flexible exchange rate
regime. In addition, the flexible nominal exchange rate regime, in conjunction
with capital account liberalization, offers larger benefits to nonoil production,
influenced by a larger accumulation of public physical capital stock, human
LIBYA: OIL-RELATED SHOCKS & EXCHANGE RATES 41

Figure 1
THE EFFECTS OF OIL PRODUCTION RECOVERY UPON KEY MACROECONOMIC
VARIABLES UNDER A FIXED AND FLEXIBLE EXCHANGE RATE REGIME
(percentage deviation from base line)

PRICE LEVEL

FOREIGN ASSET STOCKS


42 THE JOURNAL OF ENERGY AND DEVELOPMENT

Figure 1 (continued)
THE EFFECTS OF OIL PRODUCTION RECOVERY UPON KEY MACROECONOMIC
VARIABLES UNDER A FIXED AND FLEXIBLE EXCHANGE RATE REGIME
(percentage deviation from base line)

REAL EXCHANGE RATE

NONOIL TRADE BALANCE


LIBYA: OIL-RELATED SHOCKS & EXCHANGE RATES 43

Figure 1 (continued)
THE EFFECTS OF OIL PRODUCTION RECOVERY UPON KEY MACROECONOMIC
VARIABLES UNDER A FIXED AND FLEXIBLE EXCHANGE RATE REGIME
(percentage deviation from base line)

NONOIL IMPORTS

NONOIL EXPORTS
44 THE JOURNAL OF ENERGY AND DEVELOPMENT

Figure 1 (continued)
THE EFFECTS OF OIL PRODUCTION RECOVERY UPON KEY MACROECONOMIC
VARIABLES UNDER A FIXED AND FLEXIBLE EXCHANGE RATE REGIME
(percentage deviation from base line)

NONOIL OUTPUT SUPPLY

PHYSICAL CAPITAL STOCK


LIBYA: OIL-RELATED SHOCKS & EXCHANGE RATES 45

Figure 1 (continued)
THE EFFECTS OF OIL PRODUCTION RECOVERY UPON KEY MACROECONOMIC
VARIABLES UNDER A FIXED AND FLEXIBLE EXCHANGE RATE REGIME
(percentage deviation from base line)

HUMAN CAPITAL STOCK

FOREIGN CAPITAL STOCK


46 THE JOURNAL OF ENERGY AND DEVELOPMENT

Figure 1 (continued)
THE EFFECTS OF OIL PRODUCTION RECOVERY UPON KEY MACROECONOMIC
VARIABLES UNDER A FIXED AND FLEXIBLE EXCHANGE RATE REGIME
(percentage deviation from base line)

PRIVATE CAPITAL STOCK

REAL INCOME
LIBYA: OIL-RELATED SHOCKS & EXCHANGE RATES 47

Figure 1 (continued)
THE EFFECTS OF OIL PRODUCTION RECOVERY UPON KEY MACROECONOMIC
VARIABLES UNDER A FIXED AND FLEXIBLE EXCHANGE RATE REGIME
(percentage deviation from base line)

REAL PRIVATE WEALTH

REAL GOVERNMENT REVENUE


48 THE JOURNAL OF ENERGY AND DEVELOPMENT

capital stock, imported capital stock, and private capital stock. All of these add to
the productivity of the nonoil sector. In addition, the private sector benefits from
the flexible exchange rate regime, induced mainly through an increase in private
capital stock.
NOTES:
1
I. Ali and C. Harvie, “Oil and Economic Development: Libya in the Post-Gaddafi Era,”
Economic Modelling, vol. 32, issue C (May 2013), pp. 273–85.
2
International Monetary Fund (IMF), 2012 Annual Report (Washington, D.C.: IMF, 2012).
3
Ibid.
4
This revenue mainly would go to the government as the oil sector is predominantly state owned.
5
For an exhaustive review of the resource curse literature, see R. Auty, Sustaining Development in
Mineral Economies: The Resource Curse Thesis (London: Routledge, 1993) and Resource Abundance
and Economic Development (Oxford: Oxford University Press, 2001); R. Auty and R. Mikesell,
Sustainable Development in Mineral Economies (Oxford: Clarendon Press, 1998); M. Brückner,
“Natural Resource Dependence, Non-Tradables, and Economic Growth,” Journal of Comparative
Economics, vol. 38, no. 4 (2010), pp. 461–71; Y. Cai, “Resources, Revolution and Repression: The
Paradox of Plenty,” Centre for Applied Macroeconomic Analysis, Australian National University,
Canberra, Australia, 2009; O. Manzano and R. Rigobon, “Resource Curse or Debt Overhang?” NBER
Working Paper no. 8390, Cambridge, Massachusetts, National Bureau of Economic Research
(NBER), 2001; R. F. Mikesell, “Explaining the Resource Curse, with Special Reference to Mineral-
Exporting Countries,” Resources Policy, vol. 23, no. 4 (1997), pp. 191–99; E. Neumayer, “Does the
‘Resource Curse’ hold for Growth in Genuine Income as Well?” World Development, vol. 32, no. 10
(2004), pp. 1627–640; F. Rodrı́guez and J. D. Sachs, “Why Do Resource Abundant Economies Grow
More Slowly? A New Explanation and an Application to Venezuela,” Journal of Economic Growth,
vol. 4 (September 1999), pp. 277–303; M. L. Ross, “The Political Economy of the Resource Curse,”
World Politics, vol. 51, no. 2 (1999), pp. 297–322; J. D. Sachs and A. M. Warner, “Natural Resource
Abundance and Economic Growth,” NBER Working Paper no. 5398, Cambridge, Massachusetts,
National Bureau of Economic Research (NBER), 1995; J. D. Sachs and A. M. Warner, “The Curse of
Natural Resources,” European Economic Review, vol. 45, nos. 4–6 (2001), pp. 827–38; X. Sala-i-
Martin and A. Subramanian, “Addressing the Natural Resource Curse: An Illustration from Nigeria,”
NBER Working Paper no. 9804, Cambridge, Massachusetts, National Bureau of Economic Research
(NBER), 2003; P. Stevens, “Resource Impact: Curse or Blessing? A Literature Survey,” The Journal
of Energy Literature, vol. 9, no. 1 (2003), pp. 3–42; J. P. Stijns, “Natural Resource Abundance and
Economic Growth Revisited,” Resources Policy, vol. 30, no. 2 (2005), pp. 107–130; and J. P. Stijins,
“Natural Resource Abundance and Human Capital Accumulation,” World Development, vol. 34, no. 6
(2006), pp. 1060–1083; and F. van der Ploeg and S. Poelhekke “Volatility and the Natural Resource
Curse,” Oxford Economic Papers, vol. 61, no. 4 (2009), pp. 727–60.
6
This term, first coined by the Economist in 1977, is an approach to explaining the resource
curse emphasizing the declining competitiveness and productivity of the manufacturing and other
tradable sectors arising from an appreciation of the real exchange rate in the wake of a resource
boom. See M. Brahmbhatt, O. Canuto, and E. Vostroknutova, “Dealing with Dutch Disease,”
Economic Premise, vol. 16 (2010), pp. 1–7, for an extensive review of Dutch disease theory and
empirical evidence.
LIBYA: OIL-RELATED SHOCKS & EXCHANGE RATES 49
7
I. Ali and C. Harvie, op. cit. See B. K. O. Tasx and S. Togay, “Optimal Monetary Policy Regime
for Oil Producing Developing Economies: Implications for Post-War Iraq,” Economic Modelling,
vol. 27, no. 5 (2010), pp. 1324–336, for a study of the case of optimal monetary policy in the post-
war oil-producing economy of Iraq.
8
R. Dornbusch, “Exchange Rate Dynamics,” Journal of Political Economy, vol. 84, no. 6
(1976), pp. 1161–176; W. H. Buiter and M. H. Miller, “Monetary Policy and International Com-
petitiveness: The Problem of Adjustment,” Oxford Economic Papers, vol. 33 (July 1981, Sup-
plement), pp. 143–75; R. K. Eastwood and A. J. Venables, “The Macroeconomic Implications of
a Resource Discovery in an Open Economy,” Economic Journal, vol. 92 (June 1982), pp. 285–99;
W. H. Buiter and D. D. Purvis, “Oil, Disinflation and Export Competitiveness: A Model of the
Dutch Disease,” in Economic Interdependence and Flexible Exchange Rates, eds. J. Bhandari and
B. Putnam (Cambridge, Massachusetts: MIT Press, 1982); J. P. Neary and S. Van Wijnbergen, “Can
an Oil Discovery Lead to a Recession? A Comment on Eastwood and Venables,” The Economic
Journal, vol. 94, no. 374 (1984), pp. 390–95; C. Harvie and L. Gower, “Resource Shocks and
Macroeconomic Adjustment in the Short and Long Run,” The Middle East Business and Economic
Review, vol. 5, no. 1 (1993), pp. 1–14; C. Harvie and A. Thaha, “Oil Production and Macroeco-
nomic Adjustment in the Indonesian Economy,” Energy Economics, vol. 16, no. 4 (1994), pp.
253–70; G. M. Cox and C. Harvie, “Resource Price Turbulence and Macroeconomic Adjustment
for a Resource Exporter: A Conceptual Framework for Policy Analysis,” Energy Economics, vol.
32, no. 2 (2010), p. 469–89; and I. Ali and C. Harvie, op. cit.
9
I. Ali and C. Harvie, op. cit., and G. M. Cox and C. Harvie, op. cit.
10
As well as for other developing countries with similar characteristics.
11
For more discussion of the model, see I. Ali and C. Harvie, op. cit.
12
Nonoil output can be considered as a good that can be consumed either domestically or
exported and is an imperfect substitute for the foreign non-oil imported good.
13
A dot (.) above a variable signifies its rate of change.
14
These can be regarded as policy-determined parameters.
15
W. Buiter and D. Purvis, op. cit.
16
C. Harvie, “Oil Shocks and the Macroeconomy: A Short- and Long-Run Comparison,” The
Journal of Energy and Development, vol. 18, no. 1 (1994), pp. 59–94.
17
W. Buiter and D. Purvis, op. cit.
18
This is a proxy for the present value of the future income stream for the private sector.
19
C. Harvie, “The Macroeconomic Effects of Oil Shocks under Fixed and Flexible Exchange
Rates — A Comparison,” OPEC Review, vol. 17, no. 3 (1993), pp. 259–78, and C. Harvie and A.
Thaha, op. cit.
20
J. A. Frenkel and C. A. Rodriguez, “Exchange Rate Dynamics and the Overshooting Hy-
pothesis,” NBER Working Paper no. 0832, Cambridge, Massachusetts, National Bureau of Eco-
nomic Research (NBER), 1982.
50 THE JOURNAL OF ENERGY AND DEVELOPMENT
21
Inclusion of the public capital stock is attributed to the assumption that it is complementary to
that of the private capital stock in nature (see D. A. Aschauer, “Is Public Expenditure Productive?”
Journal of Monetary Economics, vol. 23, no. 2 (1989), pp. 177–200, and “Does Public Capital
Crowd Out Private Capital?” Journal of Monetary Economics, vol. 24, no. 2 (1989), pp. 171–188,
and C. J. Morrison and A. E. Schwartz, “State Infrastructure and Productive Performance,”
American Economic Review, vol. 86, no. 5 (1996), pp. 1095–1111).
22
C. Harvie and L. Gower, op. cit., and C. Harvie, “Oil Shocks and the Macroeconomy: A Short-
and Long-Run Comparison.”
23
S. E. Adjemian, H. Bastani, M. Juillard, M. Maih, F. Mihoubi, G. Perendia, M. Ratto, and S.
Villemot, “Dynare: Reference Manual, Version 4,” Dynare Working Papers no. 1, CEPREMAP,
2011.
24
Following M. H. Pesaran, Y. Shin, and R. J. Smith, “Bounds Testing Approaches to the
Analysis of Level Relationships,” Journal of Applied Econometrics, vol. 16, no. 3 (2001), pp.
289–326, and B. Pesaran and M. H. Pesaran, Time Series Econometrics Using Microfit 5.0 (Oxford:
Oxford University Press, 2009), and without having any prior knowledge about the direction of the
relationship among the variables, the behavioral equations are expressed in the form of an un-
restricted error correction model (UECM).
25
J. Lee and M. C. Strazicich, “Minimum Lagrange Multiplier Unit Root Test with Two
Structural Breaks,” Review of Economics and Statistics, vol. 85, no. 4 (2003), pp. 1082–89, and
“Minimum Lagrange Multiplier Unit Root Test with One Structural Break,” Working Paper, De-
partment of Economics, Appalachian State University, Boone, North Carolina, 2004.
26
Implying that foreign exchange reserves also will be higher, facilitating the purchase of
imported capital (technology).